"If we want to be free, then we have to have financial freedom," Andrew Povey, leader of Surrey county council, told the Conservative party conference last month. "I want to go on to develop businesses that give us more income."

Local authorities becoming profit-making businesses may seem somehow counter intuitive, but as more and more councils seek to spin out mutuals and social enterprises to deliver public services, others are setting up their own profit-making arms.

It is a move that is directly in line with government policy, injecting a healthy dose of innovation and entrepreneurialism into Britain's public services, creating new jobs in the private sector while cutting those salaries that are draining the public purse.

Kent county council's commercial division sells services – from pest control to fencing and criminal records checks – to local authorities and other public bodies. It is incredibly successful, turning over £400m a year and making a profit of £7m, according to council leader Paul Carter.

"To get innovation, we need a disruptive influence … as local government stops doing things, we will get the spawning of new social enterprises and new mutuals," Carter explains.

It is economies of scale that allow Kent's commercial division to behave in a more entrepreneurial way, and Carter puts its relatively modest profit down to its "sensible" attitude to risk.

Jonathan Carr-West, director of policy at the Local Government Information Unit, says councils' risk aversion is what has held so many of them back when it comes to setting up profit-making enterprises – despite the prospect of a better solution to local problems. Kent and Surrey are trailblazers; most councils have failed to pick up the baton on profit.

"There is a lot of anxiety about these sort of approaches and people only being willing to use them in fairly low impact services areas, but not take a risk when it comes to child services," says Carr-West.

"On the one level, that's understandable, but if you're only going to take risks on this transformation where you're spending 8% of your budget, then you can question what the point is."

The lack of appetite for risk is also a cultural problem. "There is a reason why people in public services are working for a council in the first place. If you are the kind of person that's motivated by profit, you're not going to go there."

Management and promotion structures within local government do not reward risk taking. Those achieving the most innovative and interesting things tend not to be the youngest, most enthusiastic graduates, but those at the other end of their careers who, in Carr-West's words, feel they "don't have anything to lose".

Yet those risks are plentiful. If local government is using public money to set up its own money-making services, and using the decades of council expertise to do so, can it ever be a fair competitor in the public services market? And what of the risk to reputation if residents resent local authorities becoming profit makers?

Carr-West says he believes that people don't worry who is providing their services unless they are failing to be delivered. If, for example, the bins stop being emptied, there is a higher tolerance of failure in the public sector – so spinning out services could indeed promote better services at the point of delivery.

But the problem of competition is a major hurdle. Councils cannot give newly created commercial arms a leg up into the local market because EU procurement legislation means they have to be judged on price and performance with every other bidder for the same tender. The problem raises legal and ethical questions for local authorities.

Tom Symons, researcher at the New Local Government Network, says he fears the commercialisation of local government could become a charter for lawyers.

"What you quickly realise is that a lot of authorities are interested in the idea of trading and not many are interested in the idea of it being them," he says. Councils are aware of the legal minefield and choose to skirt it, despite the opportunity to cross it and diversify their funding streams.

Solving the legal puzzle could be easy if council departments work together when planning to set up or spin out new profit-making enterprises.

"One of the key sticking points is procurement," admits Judith Barnes, partner and head of local government at law firm Eversheds. "You can't just give your staff or former staff a contract to provide a service. But it would be useful to involve legal, financial and technical colleagues early on in order to try and steer the best course … [if you do that] it is a win-win situation because the taxpayers ultimately don't pay as much if councils run more effective, agile services."

Councils must decide how to evaluate the new profit-making organisations they create. A new company does not have a track record in service delivery, unless the council takes the years spent delivering the service in-house into account. Barnes says local authorities must take clear legal advice to be sure their evaluation processes meet EU regulations.

But this process in itself could prove a solution for councils seeking to cut costs. Carr-West believes authorities could spin out a service instead of cutting and making redundancies, offering support and guidance to a group of workers to set up an outsourced company, instead of spending money on a formal redundancy package.

It could also help councils avoid both the legal and the reputation potholes in turning a profit. "I can't see any public discomfort with that," says Carr-West. "It seems a reasonable way of supporting people who may otherwise be made redundant".

Masters of communication: Westminster's outsourced press team

By 2003, Westminster council's press and communications team was undoubtedly a leader in the sector. After a difficult period, the authority had sought to focus on key skills, part of what Alex Aiken, the director of communications and strategy, calls Westminster's "drive to be good at what it does" and share its expertise.

In May 2003, Westminster signed a major contract with Richmond to share a head of communications and a team of press officers. A further deal with Harrow followed.

By 2008, the council had become a hub for communications management. It created Westco, a trading arm that outsources press and communications services to public bodies. It now presides over a "mixed economy" of contracts, mutual agreements and pro bono work to support councils in their communications efforts, which has included deals with Sutton, Southwark and the Notting Hill carnival team. Westminster also hosts three open days a year, attracting up to 50 members of public sector staff to share best practice.

The reaction to Westco from local people has been supportive, Aiken says. "People expect Westminster to make money go further; this is exactly the sort of thing that Westminster residents expect us to be doing." But he adds: "This is a subsidiary role to our primary duty as public servants. We're not aiming to be BP."